A young friend faces a difficult situation: his business has not taken off after the shock delivered by Covid. He has a young family to take care of, apart from being responsible for his parents. The slow recovery seems to have impacted small businesses the most.
Small businesses do not have a formal set up for functions, with the proprietor managing with the help of assistants for accounts, stock management and operations. Our friend inherited the business from his father. Relationships with customers, suppliers and others have been strengthened over years. The father is insistent about protecting the equity he has created and refuses the son’s request for any changes to the processes.
Much of the difficulty comes in management of working capital. Theirs is a trading business in speciality chemicals. While the applications range from architecture and interiors to medical and pharmaceuticals, they depend on a few suppliers who have worked with them for long. Customers are spread geographically and they export to a few countries. The son expanded the business globally. The father insists on paying suppliers on time, even when customers have delayed payments. The business is strapped for cash. Slowdown in revenue has meant costs of carrying unsold stocks is bleeding the business. They have raised money against the stocks as well as against debtors, but there is stress and strain from a prolonged period of low sales and high fixed costs.
Our friend has mostly insulated the family from the state of affairs in the business, drawing upon reserves kept here and there. But there aren’t many investments to draw from, as the family traditionally returns all surplus to the business. First, there is the argument of control. Why invest elsewhere and worry how the money will be used, when one can invest in one’s own business and determine how it is used? Second, there is the sheer need. When the business consistently needs funds and working capital, how could one invest in other instruments that offer a lesser return than the business?
Thus the family’s investments are lying unsold in the godowns, in a variety of speciality chemicals that cannot find a buyer even at depressed prices. A handful of their products have shown some revival in demand, clearly not enough to meet the costs. The other surpluses are invested in the luxurious home they live in, and in jewellery and gold that the family’s women own. A few pieces of land and property, not of much worth lie in distant suburbs, invested on a whim. Our young friend is staring at another year of low sales. He has been hoping for a revival in demand since October when things began to look up for many businesses. What could he do to stay afloat? What are the lessons from his personal finance experiences?
First, creating a personal corpus that is not accessible to the business is critical. It may not make economic sense at the start, as we discussed already. But it is an important diversification tool that insulates the family from the risks of the business. However high the return or control may be, keeping all the family’s assets in one business venture is a very risky decision. Even a basket of equity shares of a few large and well run companies would have provided the needed diversification for the family’s wealth. The family used equity markets like a treasury operation— invest in a few shares when there is surplus; sell off and reinvest in business when there is a need.
Second, assets should be accessible and useful when there is a need. Home that one lives in and family jewellery are both not easy to liquidate in need. A sense of panic and desperation engulfs the family when the extreme decision to sell off any of these assets is made. Having some financial investments, some shares and bonds, deposits, make it possible to tide over short and medium term difficulties. Our friend will have to sell off the distant properties and land even if at a lower price, to generate cash. To keep the business afloat during a slow revival the need is for cash and for working capital. The assets need funding until they can move and be realised.
Third, informal leverage and borrowing does not create the flexibility to take low cost loans when there is a need. Our friend’s father ran a traditional business relying on suppliers and customers to fund the business. This model works for a small scale and is informal and relationship based. There is a current account with the bank, and some working capital against buyers invoices and stocks have been raised. But not to the fullest extent possible. Now during times of crises and an uncertain and slow revenue growth, it is difficult to raise money from informal sources. The books also have to be in order and meticulously maintained to raise money from formal markets. The son has been trying to get out of the high cost relationship based funding of the business operations. This needs to be achieved even if done slowly over time, to tap NBFCs and banks for loans and leverage.
Fourth, much as it may hurt their pride, the men must get the family around and reveal the real state of the business and therefore the family’s finances. There may be fresh ideas that come from other family members. They may also willingly cut back on the demands for spending when they know the difficulties in the business. They may be willing to fund some of the business needs though their savings and assets, or draw upon finances of their networks. It is important to see this as a passing phase and ensure that the immediate family experiences the crunch too.
Fifth, a crisis is a good time to question the assumptions made about the business, its assets, costs and returns. A business that has been run for a long time might suffer hubris. It may be stuck in olden times and practices. It may face difficulties with newer markets, players and competition. While it may be fearful to unwind what has been done over many years, it may be worthwhile to ask whether the family needs to invest in and develop a new line of business that draws from the current experiences, but is modern and in line with the current markets. As the situation improves, it is important to not forget the crisis, but to begin making fresh well thought out investments. Tough times don’t last.
